December 29, 2011

Top 100 Warranty Providers:

While most manufacturers keep cutting their warranty costs, some report massive spikes in their claims and accrual rates for the year ended in September. Others continue to recover from past spikes, with some of the largest declines of the year.

Manufacturers don't typically announce a manufacturing crisis with a press release, the way that Microsoft Corp. and Nvidia Corp. have in years past. And they certainly don't announce an end to the crisis, when the cost of warranty work returns to normal.

The funny thing is, they don't have to say a word. Just by announcing what they spent is good enough. With nearly nine years of warranty data on hand, we can tell what's normal and what's unusual for any given company. And by comparing each company's most recent data to past levels, we can tell who's cutting costs the fastest or who's seeing spikes in defect levels they'd rather not tell the world about.

Every year, in the months of March, May, August and November, some 600 or so American manufacturers file their financial reports with the U.S. Securities and Exchange Commission. Each usually contains a brief chart detailing warranty expenses. And by comparing those expenses to sales figures, we can figure out what percentage of product revenue is going to warranty work.

Making A List, Checking It Twice

Before we say goodbye to 2011, we thought it might be useful to check in one more time on the manufacturers, to see who's up the most and who's down the most. And we leave out everyone in the middle. So it's a bit like making a list of all the A+ and all the C- grades, and posting it in the hallway for all to see.

We begin with a list of the 100 largest warranty providers, as measured by claims they paid during the first nine months of 2011. Then we measured their claims rate, accrual rate, and warranty reserve balance at the end of September 2010, and again at the end of September 2011. The six charts below show the ten largest annual increases and decreases in those three metrics. So the most times a company could be on a chart is three, and the least is zero.

By making the comparisons this way, we're not falling into the trap of comparing one company against another, as we would if we simply listed the ten highest and ten lowest claims or accrual rates. Instead, we're comparing each company against itself over time, using current data and year-ago data to find out which companies changed the most. Then we're listing the top ten in each direction, up and down.

Let's start with the ten biggest changes in claims rates. Out of our top 100 warranty providers, 62 were able to reduce their claims rates from September 2010 to September 2011. Amazingly, 25 of those were able to reduce their claims rates by 20% or more. And ten were able to reduce their claims rates by 42% or more, as can be seen in the right-most column of the chart below.

Figure 1
Top 100 U.S.-based Warranty Providers:
Top Ten Claims Rate Reductions,
9 Months 2011 vs. 9 Months 2010
(claims in $ millions and % of sales)

   Claims   Claims   Claims   Claims  Rate Now
  Paid Rate Paid Rate vs.
  Company  2010   Sep '10   2011   Sep '11   Year Ago 
  Harris Corp. $46 3.0% $17 1.1% -64%
  Microsoft Corp. $157 2.2% $71 1.0% -56%
  KB Home $39 3.6% $20 1.6% -54%
  Dana Holding Corp. $36 0.8% $31 0.4% -48%
  TRW Automotive $45 0.4% $28 0.2% -46%
  Boston Scientific $22 0.4% $12 0.2% -45%
  Garmin Ltd. $54 3.0% $53 1.6% -45%
  Lennar Corp. $62 2.8% $41 1.6% -43%
  Terex Corp. $68 2.2% $58 1.3% -43%
  Paccar Inc. $169 2.6% $161 1.5% -42%

    Source: Warranty Week

The claims rate is calculated by taking the amount of claims paid during a given period of time and dividing it by the total for product sales during the same period. Software and service revenue, finance income, and consumable sales are excluded from these calculations, so that warranty costs are divided by warranted product revenue wherever possible.

Microsoft Returns to Normal

For instance, Microsoft had total sales of $17.372 billion during the third quarter, but only $1.855 billion came from the Entertainment and Devices Division, which sells the Xbox and other warranted hardware. So when calculating the company's most recent claims rate, we divided its $18 million in claims payments by $1.855 billion in revenue, and got a 1.0% claims rate.

In the first quarter of 2011, Microsoft reported $31 million in warranty claims. In the second calendar quarter of 2011 (which was the final quarter of the company's fiscal year), Microsoft reported $22 million in warranty claims. So its total spending for the nine months was $71 million, down significantly from $157 million in the same period during 2010.

This is further evidence that the widely-reported manufacturing problems associated with the Xbox 360 are now well in the past. And claims are now tapering off.

A year ago, Microsoft's Entertainment and Devices Division reported sales of $1.769 billion. And the company reported $39 million in warranty claims. So it had a 2.2% claims rate at the time. Compared to its most recent 1.0% claims rate, that's a 56% improvement -- the second-best among its peers.

A few notches down the list, automotive parts supplier Dana Holding Corp. cut its claims total by $5 million, from $36 million to $31 million. That's only a 14% reduction. But the company also saw sales rise by 29%. And so, its claims rate was just about cut in half, from 0.8% to 0.4%.

At the very bottom of the list, truck manufacturer Paccar Inc. hardly cut its claims payments at all. But sales were up 65%. And so, that small reduction in dollars became a 42% reduction in the claims rate.

In the opposite direction, Harris and KB Home saw large declines in sales, but even larger declines in claims payments. Boston Scientific, Garmin and Lennar saw slight declines in sales, but large declines in their warranty payments. And their annual change in claims rates were among the largest.

Missing Companies

Of the top 100 warranty providers of 2011, 60 of them made it onto zero charts. That means the annual changes in their claims, accrual and reserve balances weren't extreme enough to make it into a top ten list. And indeed, this was the case for most of the largest warranty providers. Of the very largest, only Apple, Navistar, Paccar and United Technologies made it onto any list. And for two of those, their appearance had more to do with soaring sales than anything purely warranty-related. Bottom line, the largest warranty providers also tend to be the most stable.

Besides the warranty providers named in these charts, however, there are an additional 11 companies which report their warranty expenses only once a year, and who therefore won't publish any new data until their annual reports appear in March 2012. They are Bruker Corp.; Eaton Corp.; Flowserve Corp.; Fortune Brands Inc.; General Electric Co.; Goodyear Tire & Rubber Co.; Honeywell International Inc.; Illinois Tool Works Inc.; Motorola Mobility Holdings Inc.; Motorola Solutions Inc.; and Xerox Corp. Also, Emerson Electric Co. provides only warranty accrual data. Exide Technologies provides no warranty data. Bucyrus International Inc. was acquired during 2011, and therefore it recently ceased providing data altogether. As a result, none of these 14 companies are part of this newsletter's top 100.

It's highly likely that each of these 14 companies would be among the 100 largest warranty providers of 2011, had they followed the quarterly reporting format. And we hope to include at least 12 of them once again in April, when we publish the full calendar year comparisons. But without fresh data for the third quarter, there's no way to measure recent changes in their warranty claims, accrual, or reserve levels.

Therefore, we've drafted 14 additional companies to add to our list, in order to lengthen it to a full 100 members. Those 14 companies are B/E Aerospace Inc.; Bio-Rad Laboratories Inc.; Boston Scientific Corp.; Gardner Denver Inc.; Harris Corp.; LKQ Corp.; Middleby Corp.; Polycom Inc.; RPM International Inc.; SanDisk Corp.; Sirona Dental Systems Inc.; and Tyco International Ltd.

Multiple Appearances

Six of them made at least one of the top ten lists in Figures 1 through 6. That's opposed to 34 out of the other 86 making it onto at least one chart. By the way, of the 40 companies that made it onto at least one chart, three made it onto the maximum three charts, while 14 made it onto two charts, and 23 made it onto only one chart.

Boston Scientific made it onto Figures 1, 3 and 5, reflecting its huge reductions in claims and accrual rates as well as its warranty reserve balance. These are something to celebrate. In warranty terms, the surgical equipment company had a really bad 2008, but its claims and accrual rates have been dropping ever since. In fact, they're at their lowest point since at least 2006. Now, if only the company could get sales to go up, all four metrics would be headed in the "right" direction.

In terms of the "wrong" direction, there are two companies that made it onto Figures 2, 4, and 6 -- all three of the top ten increase charts. One was data storage company NetApp Inc. The other was aftermarket auto parts company LKQ Corp. In fact, LKQ's claims rate more than doubled from 0.3% to 0.7% in the past year, landing it in the top spot of Figure 2 below.

Figure 2
Top 100 U.S.-based Warranty Providers:
Top Ten Claims Rate Increases,
9 Months 2011 vs. 9 Months 2010
(claims in $ millions and % of sales)

   Claims   Claims   Claims   Claims  Rate Now
  Paid Rate Paid Rate vs.
  Company  2010   Sep '10   2011   Sep '11   Year Ago 
  LKQ Corp. $5.8 0.3% $16 0.7% +108%
  KLA-Tencor Corp. $13 0.9% $26 1.8% +89%
  Lam Research Corp. $18 1.0% $35 1.6% +73%
  Novellus Systems $24 2.7% $33 4.4% +61%
  Jarden Corp. $93 2.9% $108 4.5% +53%
  Harman International $12 0.5% $27 0.7% +43%
  Diebold Inc. $41 4.5% $50 6.0% +34%
  NetApp Inc. $18 0.8% $22 1.1% +34%
  Bio-Rad Laboratories $13 0.9% $18 1.2% +29%
  Eastman Kodak Co. $59 4.4% $65 5.6% +27%

    Source: Warranty Week

This was a year of recovery from the effects of the recession. Of the 100 companies we looked at, an incredible 83 saw product sales growth. As we saw in Figure 1, this in and of itself sometimes drives down the claims rate.

On the flip side, 17 companies saw product sales declines. And indeed, half the companies on the list in Figure 2 reported lower product sales: Diebold Inc.; Eastman Kodak Co.; Jarden Corp.; Lam Research Corp.; and Novellus Systems Inc. However, all five also saw dollar increases in claims payments. So both the top and bottom of the fraction were going in the wrong direction.

Accrual Rate Declines

While 62 of our top 100 were able to reduce their claims rates in 2011, an incredible 71 out of 100 were able to cut their accrual rates. The reason we say this is incredible is because accruals should always be proportional to sales. So if sales rise, so do accruals, and the percentage stays the same.

That's different from claims. Rising sales can mask rising claims payments, just as falling sales magnifies a rising claims rate. But while claims are what happens to you, accruals are what you think will happen. So 71 out of 100 companies are saying they think the products they made in 2011 are more reliable than the products they made in 2010. That's incredible.

In Figure 3 below, the top ten accrual rate cutters are detailed. There are only three repeats from Figure 1, meaning that the rest didn't also see dramatic reductions in their claims rates. But again, incredibly, it took a one-third-or-better reduction in a company's accrual rate to make the top ten.

Figure 3
Top 100 U.S.-based Warranty Providers:
Top Ten Accrual Rate Reductions,
9 Months 2011 vs. 9 Months 2010
(claims in $ millions and % of sales)

   Accruals   Accrual   Accruals   Accrual  Rate Now
  Made Rate Made Rate vs.
  Company  2010   Sep '10   2011   Sep '11   Year Ago 
  Nvidia Corp. $196 23% $4.6 0.2% -99%
  Boston Scientific $12 0.21% $8.3 0.07% -66%
  Itron Inc. $9.3 0.6% $5.6 0.2% -60%
  Ciena Corp. $16 2.5% $11 1.0% -59%
  Garmin Ltd. $54 3.3% $47 1.9% -43%
  Netgear Inc. $49 7.6% $43 4.9% -35%
  Terex Corp. $59 1.9% $57 1.2% -35%
  Brunswick Corp. $72 3.5% $52 2.3% -35%
  Oshkosh Corp. $64 0.9% $35 0.6% -34%
  Masco Corp. $30 0.9% $20 0.6% -33%

    Source: Warranty Week

As we mentioned, a change in the accrual rate is completely voluntary. Companies should keep their accruals steady with sales, so the rate changes only when product reliability or the cost of repairs changes. In Figure 3, the ten most dramatic reductions in accrual rates are listed. In Figure 4, the ten biggest increases are detailed.

Top Accrual Rate Increases

If Figure 3 contained the battered and recovering survivors of past manufacturing crises -- Nvidia, Boston Scientific and Garmin come to mind -- then Figure 4 contains the names of this year's victims. For as impressive as Nvidia's 99% reduction in accruals looks at the top of the list in Figure 3, so do the numbers at the top of Figure 4 look ominous.

Because it acquired a remanufactured engine company, LKQ had to boost its accruals from $6.1 million to $17 million. In general, the engine business is one of the most warranty-intensive sectors of the automotive industry, so this increase comes as no surprise. A 30% sales gain also contributed. But still, LKQ's accrual rate more than doubled over the year, giving it the top spot in Figure 4. The same thing happened with its claims rate, in Figure 2. And then there's that acquisition-driven 601% jump in reserves that landed LKQ atop the list in Figure 6.

Applied Materials also more than doubled its accrual rate year-over-year, from 0.76% to 1.54%. But that 0.76% rate recorded a year ago was unusually low, and this year's 1.54% is simply a return to trend. In fact, the company's claims rate has been around that level for 18 months. So it's nothing to worry about. It's simply a case of bad timing.

As for the others in Figure 4, we'll leave it to their management to explain away these massive increases in accrual rates. They can't all be caused by bad timing.

Figure 4
Top 100 U.S.-based Warranty Providers:
Top Ten Accrual Rate Increases,
9 Months 2011 vs. 9 Months 2010
(claims in $ millions and % of sales)

   Accruals   Accrual   Accruals   Accrual  Rate Now
  Made Rate Made Rate vs.
  Company  2010   Sep '10   2011   Sep '11   Year Ago 
  LKQ Corp. $6.1 0.3% $17 0.7% +109%
  Applied Materials Inc. $85 0.76% $142 1.54% +104%
  Eastman Kodak Co. $36 2.7% $58 5.0% +86%
  Hovnanian Enterprises $27 2.1% $23 3.5% +69%
  SanDisk Corp. $26 0.26% $14 0.43% +65%
  NVR Inc. $29 1.0% $23 1.6% +64%
  Cooper Tire & Rubber $15 0.63% $27 0.95% +51%
  NetApp Inc. $14 0.8% $31 1.2% +48%
  Navistar International $175 2.0% $281 3.0% +46%
  Jarden Corp. $93 2.9% $102 4.2% +43%

    Source: Warranty Week

Of the ten companies in Figure 4, only three saw falling product sales: Hovnanian, Jarden, and Kodak. And we can safely say there seems to be no correlation between rising accrual rates and falling sales. Of the 17 companies with falling sales, only five saw rising accrual rates. Besides the three mentioned, the other two were A.O. Smith Corp. and Lennar Corp.

Warranty Reserves

Finally, we turn to the last of the three basic warranty metrics: the closing balance in the warranty reserve fund. So many factors affect this balance. Indeed, we're not sure whether a shrinking balance is better than a growing balance.

A shrinking balance could mean that the company is building better products and is freeing up unneeded reserves. Or it could mean that a company is losing market share and contracting on all fronts.

A growing balance could mean a company is bulking up in anticipation of a spike in product failures. Or it could mean that claims fell sooner and faster than anyone expected, and management is sticking to its high accrual rate until they're convinced the trend is real.

In other words, the goodness or badness of a balance change is in the eyes of the beholder. We're simply listing the ten biggest percentage increases and decreases over the past year.

Note that in the downward direction, -100% is the theoretical maximum. In the words of the immortal Muddy Waters, "You can't lose what you never had." So Nvidia's 99% reduction in its accrual rate is about as good as it gets. And that, coupled with the company's 74% reduction in warranty reserves, is a sure sign that the recent manufacturing crisis caused by defective computer graphics boards, is over.

Figure 5
Top 100 U.S.-based Warranty Providers:
Top Ten Warranty Reserve Decreases,
9 Months 2011 vs. 9 Months 2010
(balance change in $ millions and percent)

   Warranty   Warranty   $ Change   % Change 
  Reserve Reserve vs. Year vs. Year
  Company  Sep '10   Sep '11   Before   Before 
  Nvidia Corp. $204 $54 -$150 -74%
  KB Home $102 $70 -$32 -31%
  Ciena Corp. $65 $46 -$19 -29%
  Mohawk Industries $39 $29 -$10 -24%
  Microsoft Corp. $214 $166 -$48 -22%
  Boston Scientific $45 $35 -$10 -22%
  Lennar Corp. $117 $92 -$25 -22%
  Rockwell Collins $183 $148 -$35 -19%
  Harris Corp. $62 $51 -$11 -18%
  Oshkosh Corp. $91 $75 -$16 -17%

       Source: Warranty Week

Eight of the ten companies in Figure 5 make appearances on other charts. Only Mohawk and Rockwell Collins make their only appearances here. This suggests that extra-large warranty reserve balance changes are simply the result of extra-large changes in claims and/or accrual rates.

However, at the other end of the spectrum, half of the companies that saw extra-large increases in their warranty reserves, as listed in Figure 6, made their one and only appearance in the chart below. Apple Inc.; B/E Aerospace Inc.; Illumina Inc.; Joy Global Inc.; and United Technologies Corp. are not listed in any of the other five charts above, suggesting that other factors are at work.

Indeed, it could be nothing more than increasing sales driving up their reserve balances. All five of the one-timers in the chart below also saw increasing product sales. Apple saw a 72% annual boost in product sales. Joy Global, Illumina and B/E Aerospace were each up by about a third over the past year. United Technologies was up about nine percent. So for them, it's simple: More sales means more warranty repairs, which requires more reserves.

Figure 6
Top 100 U.S.-based Warranty Providers:
Top Ten Warranty Reserve Increases,
9 Months 2011 vs. 9 Months 2010
(balance change in $ millions and percent)

   Warranty   Warranty   $ Change   % Change 
  Reserve Reserve vs. Year vs. Year
  Company  Sep '10   Sep '11   Before   Before 
  LKQ Corp. $0.9 $6.5 +$5.6 +601%
  NetApp Inc. $32 $60 +$28 +85%
  KLA-Tencor Corp. $26 $44 +$18 +71%
  Apple Inc. $761 $1,240 +$479 +63%
  Applied Materials $119 $188 +$69 +59%
  Itron Inc. $53 $79 +$26 +48%
  Illumina Inc. $11 $16 +$5 +41%
  Joy Global Inc. $58 $79 +$21 +37%
  United Technologies $1,105 $1,488 +$383 +35%
  B/E Aerospace Inc. $35 $47 +$12 +34%

       Source: Warranty Week

And then there are the five others: KLA-Tencor saw a big jump in claims. Applied Materials saw a big jump in accruals. LKQ and NetApp saw big jumps in both. The only one to buck the trend was Itron, which actually cut its accrual rate by 60%. But a big change in estimate drove its reserve balance up anyway.

Keeping Things the Same

Overall, there were 53 companies that saw their warranty reserve balances rise over the past year, and 45 that saw their balances fall. But that's only 98 companies. And that's because two companies -- D.R. Horton Inc. and Western Digital Corp. -- had identical balances in September 2010 and 2011.

Of the 53 companies with rising balances, 50 also saw rising product sales. Apple led that pack, but Paccar saw a 65% rise in sales, and both Caterpillar and Terex saw 47% increases. And how ironic that Caterpillar's 26% reduction in its claims rate, or Cummins' 35% claims rate reduction, both missed out getting into the top ten.

For while all of those changes were both massive and massively positive, what we're measuring here is the ten biggest changes. The idea is that within a population of the 100 biggest warranty providers, the biggest changes of all are markers for the best or worst warranty stories of the year.

We can't compare companies directly. But we can compare each company to itself. And although some of the stories have more to do with lucky or unfortunate timing than anything else, others such as Microsoft, Mohawk, Garmin, Boston Scientific and Nvidia are signs that even after virtually everything comes back broken, happy endings are still possible.

AMT Warranty Corp.
Fulcrum Analytics
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